Thursday, August 08, 2013

Tax Policy: Be Honest, and Do No Further Harm

-- Posted by Neil H. Buchanan

I am in Palm Beach, Florida, attending the annual conference of the Southeastern Association of Law Schools (SEALS). Professor Jennifer Bird-Pollan, a young philosopher and tax scholar at the University of Kentucky, has organized a Tax Policy Discussion Group, in which about a dozen tax law professors will meet later today (3:15-6:15pm), for a wide-ranging discussion of current issues in tax policy. Each of us will have only about 5-7 minutes to offer preliminary remarks, so that there will be plenty of time for discussion. Here is the gist of what I would say, if I had more time to speak. My actual comments will likely amount to reading aloud every fourth word of this blog post.

Other than the Republicans' plans to shut down the government, and then to force a government default by refusing to increase the debt ceiling, the big fiscal discussion in Washington this Fall will be about "fundamental" tax reform. I have two broad thoughts on such discussions:

(1) If we are going to have a discussion about taxes, let us finally be honest and admit that everyone uses the word "efficient" merely as a way of denoting things they like. As I have argued many times, the concept of economic efficiency is infinitely flexible, allowing advocates to honestly say that any policy is efficient or inefficient, depending on the assumptions one makes in the model that implicitly or explicitly underlies the claims.

I have recently given up on the idea that it is possible to banish the word efficiency from tax discussion. Even good-hearted people mistakenly think it means something, and Machiavellian people will use it opportunistically. So, as I have argued, we might as well overuse it, to the point where it becomes obvious that it is meaningless.

Just as a simple yet provocative example, I saw in the latest Harper's Index that the annual cost of holding a prisoner in Guantanamo Bay is $900,000, whereas the annual cost of holding a prisoner in a Super-Max prison is $65,000. At 7.2% of the cost of Gitmo, one would think that it would be a simple case to make that the Super-Max option is more efficient. Even after one starts to measure other possible costs of putting terrorist suspects in Super-Max (transportation costs, or whatever), the larger point is that a person can honestly argue that the cost-benefit analysis should include the value of knowing that terrorist suspects are not inside the United States -- a value that it is impossible to measure, but that a person can argue is greater than $835,000 per prisoner per year.

And that is simply a "partial equilibrium" example -- that is, an example where we do not even take into account the vagaries of what the costs and benefits would be if we were doing things "efficiently" in other markets. For example, I can argue that we are currently underproducing (on an efficiency basis) public transportation; but someone else can reasonably argue instead that it is inefficient to have so many people commuting at all. A policy to address my preferred target of inefficiency can thus end up creating more aggregate inefficiency.

Or less. That's the point. Not only do we not know, but we can never know, because it depends on what we decide to measure (and not measure), and how to value it.

Therefore, whatever else is going to happen in the tax debates to come, we will do everyone a big favor if we all start by calling our policy proposals efficient, and then get on with a real discussion. (And the real discussion should be about how to make the U.S. fiscal system more progressive, but there is little hope of that.)

(2) We should not be having a discussion about fundamental tax restructuring at all. This is not, of course, because our tax system is perfect. It is because, based on any reasonable assessment of the current political situation, nothing good is going to come from any tax policy change. And we certainly should not be looking for a large-scale, 1986-like fundamental rewrite of the tax code.

For one thing, no one agrees about the fundamentals. The closest we have to a consensus is that we should eliminate "tax expenditures," which are the tax provisions that are the equivalent of direct spending but have been put into the tax code. Other than violating some sense of truth-in-labeling, there is nothing deeply wrong with running a spending program through the tax code. If we do not want the government to spend money on X, then we should not spend money on X. But making that part of "cleaning up the tax code" merely confuses the issue.

Moreover, everyone already knows that none of the big tax expenditures will be eliminated or meaningfully changed (I dare not use the word "reformed"), because of their political popularity. And if any of them can be changed, we can and should do so on a case-by-case basis, without losing the possibility of positive action on one issue in the miasma of an illusory grand bargain on taxes.

What other Big Ideas are out there, that might guide debate over a fundamental tax bargain? Republicans simply want to lower rates, especially on businesses and the rich. (They claim that they also want to eliminate tax expenditures, but they will still lower rates, even if tax expenditures are unchanged.) Some Democrats offer some kind of Reagan-ish "broaden the base, lower the rates" idea, but even the most mainstream economists have now seen that the theory to support that idea is contestable, at best.

This is not to say that I could not come up with a big, fundamental change to the tax system that I might like. It is to say that we are so far from agreement even on where to begin, that the outcome of a big debate on fundamental tax reform will either be a colossal waste of time, or a final bill that is simply a bad grab-bag of giveaways to well-connected business interests who have figured out how to hide their agenda behind whatever the happy-talk label is for the tax bill.

But, one might ask, is it not true that the current tax system is simply horrible? And if we all admit that it is, then why not throw the dice, betting that anything is better than this? This, however, is where my views are truly heretical. The tax compromise that Joe Biden and Mitch McConnell negotiated on New Year's Day 2013, and which was quickly passed by Congress and signed by the President -- although a huge missed opportunity for President Obama -- actually made the tax system tolerable and sustainable. Simply put, what we have now is not that terrible. In particular, we are much better off with what we have, than with almost anything that would come from an effort at fundamental change of the tax code.

First, Biden/McConnell at least put a bit of progressivity back in the top rates. Yes, it should have been better, but it was still a movement in the right direction, and I have not heard of any proposal that might have traction that would make things better still.

Second, the complexity of the tax code is rapidly becoming irrelevant to people, as a matter of administrative/hassle costs. Tax preparation software is now so good and so cheap that only tax nerds like me have any reason to look under the hood to see what is connected to what. Again, that is not a great state of affairs, but it is becoming ever more manageable. Moreover, the probability that this will get better under anything that might come out of the current Congress is exactly zero.

Third, the Alternative Minimum Tax has been indexed to inflation. That was the only meaningful "time bomb" in the tax code, and Biden/McConnell finally fixed it. The AMT remains imperfect, essentially taxing upper-middle class people in blue states with high property taxes. (As a person who lives in Maryland and saw the AMT add about 10% to his regular tax bill in 2012, I have seen this up close.) Even so, Biden/McConnell guaranteed that it will not expand its reach further, and although people like me are not rich, we are certainly not poor, and at least we now can plan around the AMT, if we wish.

That is not to say that we should just give up, and never try to change the tax code again. More than ever, however, we are living in a world where caution in tax policy changes is called for. If we can find specific policies on which agreements can be reached, then that is great. When the political landscape is this crazy, however, it is time to count our blessings and (mostly) sit tight.